Impact of the Community Reinvestment Act on New Business Start‐Ups and Economic Growth in Local Markets*^*

* I am thankful to Bruce Kirchhoff for providing me with the data on entrepreneurial start‐ups in local markets. I would also like to thank Haizhi Wang and Iftekhar Hasan for their help with some of the estimation techniques. Usual caveats apply.

Abstract

Economic growth in the United States has historically bypassed many minorities and low‐income communities. Some researchers and community advocates assert that the deterioration of these communities is in part caused by financial institutions' redlining and neglect. To rectify the situation, the government introduced the Community Reinvestment Act (CRA) for the purpose of encouraging banks and saving institutions to become more socially responsible and help meet the credit needs of communities in which they are located.

The CRA was the government's response to bank lending discrimination. However, when passing the Act, Congress was equally concerned with reversing or at least halting disinvestment from inner‐city communities and in turn revitalizing local economies. Many believe that the availability of credit to establish, refinance, and improve small businesses is critical to the well‐being of local communities. Therefore, through the provision of small business loans, the CRA could be envisioned as a catalyst toward achieving that goal.

Thus the aim of this paper is to investigate potential relationship between banks' CRA lending activities, and new business start‐ups and economic growth in local markets. The paper proposes that new start‐ups will have spillover effects that will consequently contribute to community development. After controlling for several potential variables that could have an impact on business start‐ups and community developments, the study found a strong positive effect. Beside its social and economic implications, the study also considered policy implications associated with the CRA regulation as a welfare improving initiative in low‐income communities. It offers ground for certain government intervention in the loan market.

* I am thankful to Bruce Kirchhoff for providing me with the data on entrepreneurial start‐ups in local markets. I would also like to thank Haizhi Wang and Iftekhar Hasan for their help with some of the estimation techniques. Usual caveats apply.

* I am thankful to Bruce Kirchhoff for providing me with the data on entrepreneurial start‐ups in local markets. I would also like to thank Haizhi Wang and Iftekhar Hasan for their help with some of the estimation techniques. Usual caveats apply.

Notes

* I am thankful to Bruce Kirchhoff for providing me with the data on entrepreneurial start‐ups in local markets. I would also like to thank Haizhi Wang and Iftekhar Hasan for their help with some of the estimation techniques. Usual caveats apply.

1 Redlining is described as the practice of drawing red lines around disfavored neighborhoods where money would not be lent or invested, regardless of the creditworthiness of individual loan applicants (Thomas 1993).

2 See Scott Barancik, “Fed Governor: Study CRA to See If It Works,”American Banker, 164(106) Friday, June 4, 1999, at 2; “Gramlich Urges More Research on Impact of Community Reinvestment Act,”BNA News, Monday, June 7, 1999 (reporting on speech by Federal Reserve Governor Edward Gramlich in which he noted the dearth of empirical research on the effects of the CRA).

3 See, “Foreign Assistance Builds a Foundation for Sustainability,” by Andrew S. Natsios, U.S. Agency for International Development. http://pdf.usaid.gov/pdf_docs/PNACQ056.pdf and “First Principles of Development.” Remarks by USAID Administrator Andrew Natsios http://www.usaid.gov/press/spe_test/speeches/2002/sp020425_2.html.

4 “Business and Economic Development: The Impact of Corporate Responsibility Standards and Practices.” Report by Business for Social Responsibility and Account Ability with Brody Weiser Burns. http://commdev.org/content/document/detail/1003/.

5 In our regression estimations, we delete some of the highly correlated variables as a robustness check and find that the results associated with our focus variable are not qualitatively different than the reported results therefore we do not provide separate estimations. These estimations are available upon request.

6 We also examined employment change as an alternative proxy for economic development. The annual change or growth of employment is measured as the change in employment level from year t to year t + 1, divided by employment in year t. As with total employment, this figure was then divided by labor force to account for scale differences among the LMAs. As a robustness test, we also used a measure that examine the change in employment level from year t to year t + 2, and year t + 3 divided by employment in year t. This allowed us to see the impact beyond the initial year. In all cases these additional evidence were consistent with the reported results in the text. Although in some cases, the statistical significances were found to be weak or marginal.

7 Given that the alternative estimations were not significantly different, and in order to keep the reporting simple, we excluded estimations with lagged independent variables and results using GMM technique; and only reported OLS estimations (which incidentally show the strongest impact of the CRA variable affecting the dependent variables across all nine regressions).

8 First, we identify the banks headquartered in each of the sample LMAs. Then, we trace the amount of deposit held by each of these banks in that LMA (from Deposit Market Data) as a proportion of the total deposit (from the Call Report) held by individual banks. We substitute this proportion of deposit held by a bank in the LMA with the bank's proportion of outstanding loan in that market. In other words, we construct a variable that is an approximate measure of loan disbursed in that LMA using the proportion measure using deposit data. We realize that the measure is an approximate number and may not necessarily reflect the actual lending in that market by individual banks. However, given the constraints that no market variables are available on total loan disbursed by banks, this is an additional attempt to proxy the loan data beyond the deposit proxy used in the paper.

9 The simultaneous model can be summarized as follows:
Employment Rate or (Employment Growths) = c₀ + d₁ New Business Start‐ups + d₂ Deposits Ratio + d₃ R&D Ratio + d₄ Changes in Local Economic Environment + d₅ Educational Environment + d₆ Market Competition + d₇ Market Size + ε₁
New Business Start‐ups = a₀ + b₁ TCRAL + b₂ Deposits Ratio + b₃ R&D Ratio + b₄ Changes in Local Economic Environment + b₅ Educational Environment + b₆ Market Competition + b₇ Market Size + ε₁

10 See, for example, Schlesinger and Schroeder (July 27, 1999, A24) Wall Street Journal.

11 See U.S. Small Business Administration, Office of Advocacy, “New Advocacy Research Tracks Developments in Small Business Lending,” December–January 2007, Vol. 26, No. 1.

Additional information

Notes on contributors

Nada Kobeissi

Nada Kobeissi is associate professor in the Management Department at the C. W. Post Campus of Long Island University in New York.